Central Bank Independence and Fiscal Dominance

Author (Your Name)

Roberto Delhy Nolivos, Colby CollegeFollow

Date of Award

2010

Document Type

Honors Thesis (Colby Access Only)

Department

Colby College. Economics Dept.

Advisor(s)

Guillermo Vuletin

Abstract

The link between low levels of central bank independence (CBI) and high levels of inflation has long been established by previous literature. This literature infers that the inverse relationship between CBI and levels of inflation is caused because of the existence of fiscal dominance. This paper aims to better identify the link between fiscal dominance and different inflationary outcomes. Using a theoretical model and empirical evidence, we show that under low levels of CBI, there is a systematic correlation between changes in fiscal tax rates and changes in the level of inflation. Conversely, under high levels of CBI, there is no such systematic correlation between changes in the level of both macroeconomic variables. This shows that under low levels of CBI, the fiscal authority will use both the fiscal and monetary instruments simultaneously, whereas in the case of high CBI, the fiscal authority will not be able to use the monetary instrument and only the fiscal tax rate will have to be adjusted to finance government spending.

Comments

Full-text download restricted to Colby College campus only.

Keywords

central, bank, independence, fiscal, monetary, dominance

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